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3 Costly Mistakes Families Typically Make When Saving For College

I’m still paying for the worst mistake my family made when it comes to saving for college. I totally regret it, and I didn’t even realize it was happening until it was too late.

But I’ll get to that later…

There are three financially huge and shockingly common mistakes that families make when they put aside money for their kid’s education. Certainly most of you weren’t even thinking about doing any of these in the first place… right?

The problem is that some of these mistakes seem benign, which is why I think so many families make them. Avoiding these three costly mistakes could save your retirement, thousands of dollars in financial aid, and your kid’s life after college.

Mistake #1 Your retirement account is part of your college savings plan.

Believe it or not, a large percentage of parents think their 401(k) accounts as part of their plan for paying for college. According to our How America Saves for College survey, 1 in 4 parents that are saving for college dip into their retirement accounts to help pay for school. Some parents will take disbursements or loans from their retirement plan to avoid taking out student loans.

Your retirement account may be the biggest financial asset you have, so it only seems natural to tap into those funds to cover a big expense like your child’s education. But it’s a terrible idea for a couple of reasons:

1. Money that you cash out of your retirement plan is considered income and it will count against you when you apply for financial aid the following year. Talk about backfiring.

2. Most parents with college-bound students are somewhere between age 40 and 60. That means if you’re 55 and sending your kid off to school, you don’t have much time before retirement to make up those withdrawn funds. Borrowing from your retirement plan could save you from taking out student loans, but it could also postpone your retirement.

3. It’s easy to get a loan to pay for college. It is not easy to get a loan to pay for retirement (I don’t know many retirement loan plans out on the market…). So while there are plenty of options to finance your child’s education, like grants, federal loans and institutional financial aid, there are not many options for you if you want to retire and you don’t have enough stocked away to pay for it.

Mistake #2 You’re saving under your child’s name.

It’s an easy step, and it’s one of the most important. If you want to maximize your family’s financial aid, make sure any accounts earmarked for college are under your name, not your child’s. Assets in accounts owned by a student, like a regular savings account or even Uniform Gifts to Minors Act (UGMA) or Uniform Transfers to Minors Act (UTMA) accounts are taxed at a much higher rate when calculating financial aid than accounts under a parent’s name (20% vs. 5.64%). That means if your kid has $1,000 in his account, he’s expected to use $200 for college. But if that $1,000 was in your name, you’d only be expected to contribute $56 of that money toward school.

Also, investing your college savings in an account under your child’s name means you have limited control you have over that money. When your kid reaches the age of 18 or 21, depending on the state you live in, savings in a custodial account will transfer over to your child.

I’d bet that you have responsible and honest children. But do you really want to bet thousands of dollars of your savings on your kid doing the right thing and using all of that money for college?

I didn’t think so.

If I were a 21-year-old in school and $10,000 was suddenly transferred over to my name, you can bet I wouldn’t use all of that money for tuition… there are just too many expensive, “educational experiences” to be had in college 🙂

Mistake #3 You stop saving once college starts.

Guess what happens after your kid graduates from college? Real life and student loans. Both of which cost a lot of money.

Whether you’re giving your kid a stipend, or he’s earning his own cash through a part-time job, keep encouraging your kid to save while he’s in school. If I could go back in time and give myself one piece of financial advice in college, it would be this: save up a few thousand dollars to use for post-grad life. When I graduated from school, I barely had enough money to put a security deposit on an apartment. My lack of cash meant my options were limited, and like many college grads in a bad economy, I had to take whatever job I could get so I could just pay the bills.

If you’re a generous parent who wants to help your kid get on her own two feet after college, consider setting some money aside as a “getting through the real world” fund to give you kid as a graduation gift. If you expect your grad to make it on her own, be sure she knows how much life after college costs and push her to save some of her disposable income.

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Oh, and the worst mistake my family made saving for college?

Not saving anything at all.

It’s part of the reason I’m thousands of dollars in debt. Whatever you do, start saving for college early. Don’t worry about maximizing your tax claims or signing up for the right account – you can figure it out as you go. The most important thing is to just get started.

Looking for more strategies to prepare your kid for life after college? Get my free eBook: Recession Proof Your Kid. Just fill in your information below.

5 thoughts on “3 Costly Mistakes Families Typically Make When Saving For College”

Well detailed post. People should start saving for college when they are young. I started a savings account when I was 10 and any money I earned or received as gifts went in there. Plus back then interest rates on savings accounts was 20% or more so I was fortunate enough to apy for college with my savings account and still have money left for a new car.

Right, it’s never too early to start saving for college, maybe the biggest mistake is not starting earlier. This advice of course is no use if you’ve left it too late, but if it still applies to your situation then start now!